Marijuana Is The Next Big Investment, But Here's Why Most Investors Will Have To Wait

California is one the latest states to legalize recreational marijuana. With Proposition 64 going into full effect on Jan. 1, 2018, we could be one step closer to new federal regulations, which would make investment opportunities in the marijuana industry more accessible to everyone.

Cannabis-related businesses constitute one of the fastest growing industries in the United States. The medical marijuana market alone was worth $4.7 billion in 2016 and is expected to grow to $13.3 billion by 2020. Meanwhile, adult recreational sales amounted to $2.6 billion in 2016 and could reach $11.2 billion by 2020. With promising revenue and expansion across states, industries and product offerings, the marijuana industry has become an attractive opportunity for investors.

But until now, investor participation in the legal cannabis market has been relatively small. Will that change? And, if so, how can investors get in on the ground floor?

Limited Opportunities in the Past

Silicon Valley has been funneling capital into the cannabis industry since the early stages of the legalization process, but this space remains closed to the average investor. The only way for individual investors to take advantage of the industry's 16 percent projected annual growth rate is to make a direct investment in a marijuana business or to join a syndicate group as a limited partner. However, this approach is not a viable option for most investors due to the amount of capital required, access to deals, and illiquidity.

Marijuana Annual Growth Rate

New Frontier Analytics

Even indirect exposure via pharmaceutical and medical research companies is extremely limited, unless you have millions to invest like PayPal co-founder Peter Thiel, who recently invested in the Seattle-based private equity firm Privateer Holdings, which funds marijuana-related medical research and products.

The main obstacle to investing in cannabis comes from federal regulations. Even though 29 states currently have some form of legally permissible medical or recreational marijuana use, pot is still a Schedule I regulated substance in the eyes of the federal government.

Current federal regulations mean that companies involved in the marijuana space cannot go public. The SEC requires companies to meet some strict standards before they can be traded on the stock market, so any kind of involvement with the cannabis industry could run afoul federal laws. Publicly-traded pharmaceutical and biotech companies deliberately stay away from the cannabis industry for this very reason.

The average investor will eventually be able to buy shares in companies that produce or distribute marijuana, invest in cannabis-related funds and securities and maybe even purchase marijuana futures – but first, a few things need to happen.

Reform on the Horizon

There’s a need for the federal government to pass legislation that would align with the stance most states are taking on medical and recreational marijuana. Canada's nationwide marijuana legalization could provide the U.S. with a template to follow for federal and state governments to work together. However, since full legalization at the federal level isn’t likely to happen soon, reform has to start in the states which it has.

Marijuana State Results

New Frontier Analytics

Some states will need to clarify their marijuana-related legislation. Currently, gray areas leave businesses and consumers unprotected and make it difficult for companies to access financial services such as loans, banking or even credit card processing. Clarifying legislation at a state-level would make it easier for pharmaceutical and biotech companies to invest in the marijuana space and for financial companies to offer their services to cannabis companies. This is key – because, as of right now, the industry essentially runs on hard currency with little to no credit or financing options.

Before it can grow and move away from a model that heavily relies on cash, the cannabis industry needs to secure access to financial markets. But due to federal regulations, banks and even insurance companies stay away from businesses involved with the production and distribution of marijuana. Instead, growers, dispensaries and even research labs have to secure financing from credit unions or angel investors. Come Jan. 1 in California, the Cannabis Banking Working Group could make financing more accessible to this industry, but access to financial services in every state would only become available if the federal government passes the SAFE Banking Act or other future legislation that would provide legal protections.

The marijuana industry is booming, and once we see these changes take place, we will likely see investment ramp up creating greater demand for funds and other financial instruments focused on this space. Soon, we could possibly have access to investment opportunities in companies that develop new products like THC-infused skin patches, new services such as cannabis delivery or new technology like devices that work as breathalyzers for drivers. Meanwhile, a host of supporting services tied to the cannabis-industry, including finance, insurance, logistics, tech and medical research could grow with it.

The stigma that surrounds marijuana is changing as more Americans have access to medical or recreational marijuana. Investment opportunities are still limited to a few wealthy investors, but there is a demand for retail investment products, both from investors and from the cannabis industry that needs capital to sustain its growth. Federal regulations are the missing piece of the puzzle for now, but this could change in the near future.